The Survival of Islamic Banking : A Micro-Evolutionary Perspective

Many economists have studied the macroeconomic properties of interest-free banking in the framework of an isolated and ideal Islamic economy. In this age of integrated global financial markets, it is important to consider an alternative model where interest-based and interest-free banking co-exist. I present an evolutionary game-theoretic model in which strictly profit loss sharing (PLS), regular interest-based banks, and banks with Islamic windows interact. In this model, an ideal PLS regime would be the most prosperous, even from a purely financial standpoint. However, the PLS institutions are in jeopardy if they have to compete with conventional banks. It is shown in this model that in the face of competition with interest-based institutions, a critical initial mass of the hybrid type is necessary not only for the survival but also efficiency of the PLS in a heterogeneous environment